When it comes to choosing an entity type for a business, the options can seem daunting. Sole Proprietorship or LLC? Partnership or Corporation? Understanding each type of entity is essential for helping your clients make the right decision for their business, one that strikes the right balance of providing liability protection and simplicity while reducing tax and compliance obligations.
For real estate professionals, the decision is especially nuanced. Whether an agent, a broker, or another real estate professional, adopting the right type of business structure can mean the difference between success and struggle. That said, not every entity type is ideal for every client, so it’s best to understand the pros and cons of each. A summary of each follows.
Common Entity Types for Real Estate Businesses
- Sole Proprietorships: This type of business entity has one owner/operator. Profits and losses are reported on the owner’s personal tax return. They are easy to establish with minimal paperwork and compliance obligations. However, they do not provide personal liability protection for owners.
- Partnerships: Similar to sole proprietorships, these businesses have two or more owners, with profits and losses being split among the owners’ personal returns. They are also easy to start up and maintain, but do not provide personal liability protection.
- Limited Liability Companies: LLCs offer the simplicity of sole proprietorships and partnerships but protect the owner’s personal assets from business liability. Profits and losses pass to the owner’s personal tax returns. They require a bit more paperwork to set up as well as ongoing compliance. One downside is that owners/members are subject to self-employment taxes.
- C Corporations: C Corps are ideal for growing companies that may be seeking outside investors. They offer strong personal liability protection but are subject to more regulation and compliance obligations. One negative is that they can face double taxation, in which profits are taxed at the corporate level and again at the personal level when shareholders receive dividends.
- S Corporations: S Corps aren’t a formal entity type, but rather a tax election available to C Corps and LLCs. Under this structure, businesses can become pass-through entities, in which profits are passed through to the owner’s or shareholder’s personal tax return, thus avoiding double taxation.
Other Business Entity Types for Real Estate Professionals
For licensed real estate professionals, such as agents and brokers, there are other business entity options: Professional Corporations and Professional LLCs. Designed for those working in industries in which state licensure is required (such as real estate, law, medicine, architecture, and many more), these entities shield their owners from personal liability in professions in which lawsuits or malpractice claims are more common. More specifically, they can protect business owners from claims against other members of their PC or PLLC. It should be noted that they do not protect the owner against liability stemming from their own actions, so professional liability insurance — Errors and Omissions Insurance for real estate professionals — is still required.
Another caveat to PCs and PLLCs is that their requirements vary widely from state to state. Some states do not recognize them as business entities at all, while others only recognize PCs, but not PLLCs. Other states require professionals to form professional entities rather than standard entities. Each state outlines which professions are eligible for professional entities, but in most states, real estate agents/brokers can form either PCs or PLLCs.
Although the requirements vary by state, generally speaking, Professional Corporations and Professional LLCs must abide by the following restrictions in most states:
Professional Corporations
- All shareholders and/or board members must be licensed in the industry in which services are offered
- Services offered are limited to the licensed industry
- The business name must identify that it is a professional corporation
- A PC must get permission to incorporate from the appropriate state licensing board
Professional Limited Liability Companies
- All (or in some states, a majority) of members must be licensed in the industry in which services are offered
- Services offered are limited to the licensed industry
- A PLLC must notify the appropriate state licensing board of their intent to organize
- PLLCs must choose whether to be member-managed or manager-managed, depending on the state
Like standard Corporations and LLCs, Professional Corporations and Professional LLCs must do the following:
- File articles of incorporation or organization
- Designate a registered agent
- Obtain an EIN
- Register for payroll taxes
- Obtain applicable business licenses
- Open a business bank account
- Draft corporate bylaws or create operating agreements
Factors to Consider When Choosing a Business Entity
Because every real estate business is different, there’s no one-size-fits-all approach to determining an entity type. Factors to consider include the following:
- The type of business. For example, a brokerage firm will have different needs than a real estate investment firm.
- The size of the business. A single broker-agent will have different needs than a large brokerage with multiple agents or owners.
- The client’s business goals. Companies looking to scale or those seeking investors will differ from a veteran agent close to retirement.
- Risk tolerance. Real estate investors and developers may have risk tolerance levels that differ from individual agents or brokers. Some real estate professionals may not want to put their personal assets at risk.
- Administrative tolerance. Corporations and Professional Corporations require more regulatory compliance than LLCs or sole proprietorships, and some business owners may not be willing or able to take that on.
- Financial considerations. Some business owners may want to avoid self-employment taxes, some may want to avoid double taxation, and some may want to avoid the start-up costs of incorporation.
Business Entity Selection Requires Careful Consideration
The decision of how to structure a business is a crucial step in forming and running a business. In fact, the decision can impact every aspect of day-to-day operations. For real estate professionals, it is especially important to choose the right entity type, as fluctuations in the market result in an ever-changing industry. Each business is unique and demands unique consideration, taking into account a variety of factors. By approaching the decision with care, it’s possible to help your clients make the right decision, one that will position them for success for years to come.
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Nellie Akalp is an entrepreneur, small business advocate, and mother of four. A pioneer in the online legal document filing space since 1997, Nellie has helped more than half a million small businesses and licensed professionals start and maintain companies across the United States, most recently as the founder and CEO of CorpNet.
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